by steve snyder, managing director, form follows function€¦ · rooted in the natural world, the...
TRANSCRIPT
INSIGHTONLINE | fall/2014 1
by Steve Snyder, Managing Director,
Head of Multi-Asset Program, Commonfund
form follows function
The design axiom captures the purpose of multi-asset investing
INSIGHTONLINE | fall/2014 2
nterest in multi-asset investing
is growing and the inflows
confirm it: Institutional assets
committed to multi-asset
investing are reported to have
increased to $773 billion at
year-end 2013, up from $442 billion at year-end
2010, while the second quarter of 2014 repre-
sented the 11th consecutive quarter of fund flows
into the strategy. The trend isn’t confined to
the U.S., either, as industry data indicate that in
Europe some €62.5 billion was committed to
multi-asset funds in the first six months of 2014.1
What is multi-asset investing? Definitions vary
somewhat, but at its core it is about an efficient,
resource-effective approach to maintaining a
well-diversified portfolio. Multi-asset investing
ranges from equity-specific or fixed income-
specific funds to a single, commingled vehicle
combining traditional domestic and international
equities, emerging market equities, domestic
and global fixed income, short-term securities/cash,
and a range of alternative investment strategies.
Forms of multi-asset investing can be found across
a sliding scale—from a stand-alone strategy
that is one allocation within an overall portfolio
to a fully outsourced chief investment officer
(OCIO) program at the other extreme.
The current surge of interest is actually a case
of back to the future. The concept dates to the
1960s and ’70s, when it was also referred to as
balanced investing, although at that time strat-
egies were typically confined to U.S. equities and
fixed income in the traditional 60/40 split.
Providers were primarily large banks and tradi-
tional asset managers. Interest waned in the
’80s, as boutique investment firms emerged along
with consultants serving in the role of asset
allocator. Multi-asset investing began to return to
prominence in the mid-2000s and has been
gaining momentum since, a trend that can be
attributed to many factors, including enduring
recognition of the seminal study by Brinson,
Hood and Beebower concluding that more than
90 percent of the variation in quarterly return
could be explained by asset allocation decisions.
Although there are as many versions of a
well-diversified portfolio as there are institutional
investors, the desirability of a well-diversified
portfolio is a near-universally accepted axiom. Yet,
it’s easier said than done. Constructing and
maintaining that well-diversified port folio is a
considerable challenge—and, thus, the funda-
mental rationale for multi-asset investing. For
resource-constrained institutions, imple-
mentation is easier, the management of fund
flows in and out is simplified, and important
considerations—such as risk management,
reporting and rebalancing—are usually integrated
into the program.
Increased portfolio complexity
drives adoption
A closely related factor driving multi-asset
investing—as well as the related trend toward
outsourcing—has been the increasing com-
plexity of portfolios. This is accompanied by the
realization—particularly on the heels of the
financial crisis—that many investment committees
don’t have the time to perform effective, timely
oversight of portfolios. Typically, committees meet
four times a year, and when they get together
governance and policy issues often top the agenda
(as they should). In all but a handful of
instances, constrained staff size—and, in some
instances, staff turnover—makes it difficult to
adequately support investment committees with
internal resources.
I
1 Sources:Pension&Investments,eVestmentsandThomsonReuters.
INSIGHTONLINE | fall/2014 3
Risk management, reporting and rebalancing are
important benefits of multi-asset investing.
There are varying levels of risk management, but
three, in particular, have come into their own
in the past few years:
Failure to meet institutional objectives;
Operational risk, including due diligence and
oversight of managers; and
Portfolio liquidity/illiquidity.
Not meeting institutional objectives is foremost
on the minds of trustees, who recognize that
endowment performance is critical to mission.
Many investment committees have a long-term
objective of earning a rate of return that meets
or exceeds spending plus inflation and manage-
ment expenses. For most nonprofits, that’s annual
spending of around 5 percent or, somewhat
more conservatively, 4½ percent. With inflation
pegged in the range of 2 to 3 percent, the
resulting goal of 7½ to 8 percent to maintain
purchasing power is not an easy hurdle.
The drive to meet institutional objectives
The traditional combination of asset classes
—60/40, 70/30 or 75/25—may not get the job
done. Thus, institutions have had to think
about two things. First, lowering their spending
rate or, at the least, smoothing spending
through time; second, seeking to affect returns
through the asset allocation mix, for example,
constructing their portfolios with an equity bias
and pursuing capital appreciation by including
private capital or private equity real estate.
Investors have also sought to build in downside
protection, which has led to introducing
selected hedge fund strategies into their portfolios.
And then, certainly, inflation hedging has
been a much discussed risk over the past couple
of years, and we’ve seen greater interest in
inflation hedging strategies (so-called real assets)
being incorporated into portfolios.
Risk number two entails operational factors
and due diligence. Even institutions with the
most sophisticated investment committees face
time constraints. What’s attractive about
the providers of multi-asset vehicles is that they
typically tend to be deeply resourced invest-
ment firms that are building portfolios from the
ground up, including consulting on asset
allocation, finding best-of-breed managers and
performing portfolio analysis, often including
risk aggregation.
The third area is liquidity. One advantage
of multi-asset funds is retaining managers,
particularly in the alternative strategies space,
that institutions may not be able to access
on their own. While that may make portfolios
less liquid, some multi-asset funds have
responded by providing accelerated liquidity.
The multi-asset investor, for example, would
gain access to hedge fund strategies, but not be
subject to the same lockup terms as a direct
investor in the hedge fund.
Higher importance given to reporting
Reporting is another major consideration. After
the financial crisis, the industry has seen a
much greater demand for transparency, elevating
the importance of reporting for all investment
managers, particularly multi-asset providers owing
to the complexity of those portfolios, i.e.,
Constructing and maintaining a well-diversified portfolio is a considerable challenge —
and, thus, the fundamental rationale for multi-asset investing.
INSIGHTONLINE | fall/2014 4
multiple strategies and multiple managers in
one blended portfolio. Investors today want to
know what they own and why. Thus, the
development of a point of view becomes critical
and, arguably, even more important is artic-
ulation of that point of view, allowing the investor
to understand exactly why the portfolio is
positioned the way it is.
Another service is the rebalancing that usually
takes place on a regular basis for multi-asset
portfolios. Thoughtful multi-asset portfolios are
constructed with a long-term point of view
(forming the “equilibrium portfolio” or “policy
portfolio”). As there are real-time events
demanding attention, the underlying managers
may reposition portfolios daily, when needed.
Generally, however, refinements in the target
allocation based on shorter-term opportunities
and risks in the capital markets will take
place on a monthly basis.
Benchmarking, a potential hurdle when
multiple asset classes are involved, is generally
addressed at two levels. Current performance
is gauged by measuring the total portfolio
(or broad asset classes for multi-asset equity and
fixed income funds) or by creating weighted
composite indices to serve as reference benchmarks
to understand what is driving performance.
Over the longer term, performance is often weighed
against policy goals, such as the institution’s
annual effective spending rate plus inflation and
costs. (Commonfund offers a third benchmark
of performance analysis compared with a set of
peer institutions.)
COMMONFUND A MULTI-ASSET LEADER
SINCE ITS FOUNDING
When Commonfund was founded in 1971, its
very first investment program was the Multi-
Strategy Equity Fund, followed a few years
later by the Multi-Strategy Bond Fund—two
multi-asset funds that still exist today.
Two years ago, Commonfund formalized
its Multi-Asset Program,™ offering a com-
prehensive range of asset classes and strategies
and client preference for discretion ranging
from retained to shared. The program includes
dedicated client service officers, investment
flexibility, operational oversight, technology
support and transparency at multiple
portfolio levels.
In February 2014, Commonfund launched
a new tool—the Client Reporting Portal,
which is accessible through Commonfund’s
website—to help multi-asset clients
efficiently access the portfolio information
and analytics they want, when and where
they want them.
INSIGHTONLINE | fall/2014 5
Who are multi-asset programs for? A major
source of demand has been smaller and mid-sized
institutions because of issues such as resource
constraints and manager access, as discussed previ-
ously. That said, there has been a great deal of
interest from larger institutions as well, owing to
ease of entry, a lighter administrative burden,
a single custodian and year-end reports that meet
audit requirements. Institutions of all sizes also
like the ability to be nimble—to respond quickly
when needed, without having to wait for buy-
in and approval from investment committees at
quarter-end.
Multi-asset investing in a hybrid model
Within the investing world there seem to be almost
as many approaches as there are institutions.
In many ways this makes sense as issues and needs
are unique. For example, larger nonprofit
institutions that work with consultants often use
an implemented consulting model, in which
varying degrees of fiduciary responsibility are
delegated. In these instances, the consultant may
make recommendations, based on an open
architecture platform, concerning asset allocation,
portfolio construction, and manager selection
and monitoring. Much depends on whether the
institution wants to outsource administrative
functions. Those that really want a diversified
portfolio but still want to maintain some
control in a shared discretion environment
might gravitate toward the multi-asset program.
The same challenge exists as was discussed
earlier in terms of the timeliness of changes to the
port folio, even within a consulting model.
So, what we’ve seen in some cases is consultants
advocating that a portion of the portfolio—
say, about 15 percent—be dedicated to what is
called “asset allocators,” but which is very
much the same as multi-asset investing. This
portion of the port folio would be actively
managed to reflect the current market environ-
ment, while the remaining 85 percent would
be managed, essentially, as the policy portfolio.
Conclusion
Rooted in the natural world, the “form follows
function” philosophy has found its way into
architecture, product design, software engineering
and other fields. Multi-asset investing is no
different. It is an approach to investing that takes
its form as a result of the function it performs
for institutional investors including:
meeting the challenge of building and managing
well-diversified portfolios; managing the
increasing complexity of today’s portfolios;
the need for robust risk management
and transparent reporting; access to managers
and strategies; and
the speed and agility to respond to rapidly
changing capital market environments.
Multi-asset investing takes no single form; once
again, it responds to the function it performs
—from asset class- or strategy-specific allocations
with client retained or shared discretion to
comprehensive solutions.
Multi-asset investing responds to the
function it performs.
INSIGHTONLINE | fall/2014 6
DISCLOSURE STATEMENT
CommonfundInsightforStrategicInvestors(“Insight”)hasbeenprepared
andpublishedbyTheCommonFundforNonprofitOrganizationsanditsaffiliated
companies(collectively,“Commonfund”).
AnymentionofCommonfundinvestmentfund(s)withinInsightisnotintendedto
constituteanoffertosell,orasolicitationofanoffertobuy,interestsinsuch
fund(s).Offeringsofanyinterestsinfunds(oranyothersecurities)mayonlybe
madebymeansofformalofferingdocuments,suchasInformationforMembers
(forendowmentfunds)ortheapplicableconfidential placementmemoranda.
Investorsshouldconsulttheofferingdocumentsandanysupplementalmaterials
beforeinvesting.Readallmaterialscarefullybeforeinvestingorsendingmoney.
Statementsmadebythird-partyauthors,intervieweesorbyCommonfundauthors
inInsightthatpertaintoanyclassofsecurity,orthatofaparticularcompany(s),
maynotbeconstruedasanindicationthatCommonfundintendstobuy,holdorsell
suchsecuritiesforanyfund,orthatithasalreadydoneso.Mentionsofsuccessful
companiesshouldnotbereadtopredictthefutureperformanceofthosecompanies
orofanyfund.
EconomicandinvestmentviewspresentedbyanyauthorswithinInsightdonot
necessarilyreflectthoseofCommonfund.Viewsadvancedbythird-partyauthors
maybebasedonfactorsnotexplicitlystatedinInsight.Viewscontainedwithin
Insight(includingviewsonassetallocationorspendingpolicies,aswellasinvest-
mentmatters)mustnotberegardedasrecommendationsorasadviceforthe
reader’sinvestmentuse.Additionally,alleconomicandinvestmentviewspresented
arebasedonmarketorotherconditionsasofthedateofthispublication’s
issuance,orasotherwiseindicated.Commonfunddisclaimsanyresponsibilityto
updatesuchviews.
InvestmentmanagersutilizedbyCommonfundmayormaynotsubscribetothe
viewsexpressedinInsightwhenmakinginvestmentdecisionsforCommonfund
funds.TheviewspresentedinInsightmustnotbeinterpretedasanindicationofthe
tradingintentofmanagerscontrollingCommonfundfunds.
PastperformanceofanyCommonfundfundisnoguaranteeoffutureresults.
Referencestoreturnsofparticularmanagersorsub-strategiesofCommonfundfunds
arenotindicativeofthefunds’returns.SecuritiesofferedthroughCommonfund
Securities,Inc.(“CSI”),amemberofFINRA.